“The only missing ingredient for such a correction currently is simply a catalyst to put ‘fear’ into an overly complacent marketplace. There is currently no shortage of catalysts to pick from whether it is further fiscal policy missteps stemming from the upcoming “Debt Ceiling” debate, a resurgence of the Eurozone crisis, or an unexpected shock from an area yet to be on our radar.

In the long term, it will ultimately be the fundamentals that drive the markets. Currently, the deterioration in the growth rate of earnings, and economic strength, are not supportive of the speculative rise in asset prices or leverage. The idea of whether, or not, the Federal Reserve, along with virtually every other central bank in the world, are inflating the next asset bubble is of significant importance to investors who can ill afford to lose a large chunk of their net worth.”

“The word ‘bubble’ gets tossed around an awful lot ever since the Nasdaq bubble and the housing bubble. I guess it’s not that surprising.

But first, what is a ‘bubble’? I define a bubble as follows:

‘A bubble is an environment in which the market price of an asset has deviated from the underlying asset’s fundamentals to an extent that renders the current market price unstable relative to the underlying asset’s ability to deliver the expected result.’

When I try to decipher whether a market is in a bubble I don’t like to rely on valuation metrics because I think bubbles are often the result of irrational behavior that makes valuation metrics unreliable for long periods of time. Instead, I prefer to look at underlying fundamentals relative to behavior. When I look at the current equity market I see corporate profits growing modestly, an economy that is expanding modestly and an equity market that is increasingly enthusiastic, but not showing the types of pure exuberance, greed and delusion that are typical in a bubble environment. There’s still a huge amount of skepticism about the equity market rally. This remains an extremely hated rally.

So, I would say there’s growing risk as we’re seeing increasing signs of euphoria, but I wouldn’t yet describe this as a ‘bubble’. I think that implies much more downside risk than is currently present in the economic and corporate fundamentals. And perhaps more importantly, we’re just not seeing the kind of all out delusion that usually accompanies a bubble. When people at dinner parties start telling me that stocks can’t go down then I’ll start getting scared.”

However, there is one potential overriding issue that suggests that we might have not yet reached the peak of irrational exuberance…there is simply too many people talking about a“bubble in stocks.”

Throughout history, there have been repeated boom/bust market cycles and at the peak of each previous bubble the common mantra was “this time is different.” The reality is that the vast majority of market participants only realize the bursting of a bubble after the fact. This time is likely no different. Bob Farrell’s Rule #9 states that when all experts agree that something else is bound to happen. If the majority of professional investors being paraded on television are talking about the potential of a Federal Reserve driven asset bubble; it is unlikely to be the case.

Chris’s comment on the 13-year breakout of stocks is important, however, it is no more important than the breakout of stocks witnessed at the peak of the market in 2007. While the breakout does clear the markets of overhead resistance on a technical basis – it also marks the beginning of the next major market top. As far as the economy is concerned it is indeed growing but only sluggishly at best. That growth can, and likely will, deteriorate rapidly as the Affordable Care Act sinks its teeth into the relative little disposable personal income currently available to the average American family. The chart below shows the S&P 500/GDP ratio. The stock market should be a reflection of the underlying economic strength, however, stocks have currently detached from economic fundamentals.

That leaves the central bank. Despite signs of growing exuberance in the markets; the Fed is highly likely to remain engaged in their ongoing QE programs longer than most expect. As I discussed previously in “What Is A Liquidity Trap?:”

“The issue is that with each economic cycle rates continued to decrease to ever lower levels. In the short term, it appeared that such accommodative policies did aid in economic stabilization as lower interest rates increased use of leverage. However, the dark side of those monetary policies was the continued increase in leverage which led to the erosion of economic growth, and increased deflationary pressures, as dollars were diverted from productive investment into debt service.

Today, with interest rates at zero, the Fed has had to resort to more dramatic forms of stimulus hoping to encourage a return of economic growth and controllable inflation. The Federal Reserve is currently betting on a ‘one trick pony’ that by increasing the ‘wealth effect’ it will ultimately lead to a return of consumer confidence and a fostering of economic growth? Currently, there is little real evidence of success.”

That lack of “economic success” will likely mean that the Fed remains engaged in its ongoing QE programs for much longer than currently expected. The real surprise in 2014 could very well be an increase in size and scope of the current quantitative easing programs if interest rates remain elevated, deflationary pressures continue to increase and economic growth stalls. The injection of more liquidity could very well drive asset prices to the irrational extremes of a true market bubble. However, if that occurs, the majority of market analysts and economists will not be talking about a “bubble” in asset prices but why “this time is truly different.”

Are we currently witnessing a market bubble? It is entirely possible, but if it is it will be the first market bubble in history to be seen in advance. From a contrarian investment view point, there is simply “too much bubble talk” currently which means that there is likely more irrational excess to come.

About The Author

After having been in the investing world for more than 25 years from private banking and investment management to private and venture capital; Lance has pretty much “been there and done that” at one point or another. His common sense approach has appealed to audiences for over a decade and continues to grow each and every week.

Lance is also the Chief Editor of the X-Report, a weekly subscriber based-newsletter that is distributed nationwide. The newsletter covers economic, political and market topics as they relate to the management portfolios. A daily financial blog, audio and video’s also keep members informed of the day’s events and how it impacts your money.

Lance’s investment strategies and knowledge have been featured on Fox 26, CNBC, Fox Business News and Fox News. He has been quoted by a litany of publications from the Wall Street Journal, Reuters, The Washington Post all the way to TheStreet.com as well as on several of the nation’s biggest financial blogs such as the Pragmatic Capitalist, Zero Hedge and Seeking Alpha.